Options for Reforming the Estate Tax

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I. Introduction

Under current law, the estate tax is reduced gradually through 2009, repealed in 2010, and then reinstated in full force in 2011. Few expect things to actually play out that way. President Bush and many members of Congress would like to repeal the tax permanently, and many would like to do so before 2010. Repeal would be expensive, however: Immediate repeal would reduce revenues by more than $400 billion over the next decade. Even making repeal permanent as of 2010 would cost $270 billion in the next 10 years. Repeal would also be regressive, would reduce charitable giving by more than $15 billion a year, and would invite significant tax sheltering activities. It would increase the concentration of wealth, and may also increase the political power of a wealthy elite.

Critics of the estate tax argue that it burdens small farms and businesses with confiscatory tax rates, discourages work and thrift, and retaxes money taxed under the income tax. In fact, few small farms and businesses appear to be subject to the estate tax although many families may undergo costly planning to avoid it. The empirical evidence on saving behavior is ambiguous: The tax may discourage work and saving for people subject to it, but it has the opposite effect on heirs who—expecting smaller bequests — choose to work harder and save more. And while it may ‘‘double-tax’’ income in some cases, much of the wealth subject to estate tax was earned through untaxed capital gains and so has never been subjected to the income tax.

In contrast to repealing the tax, retargeting the estate tax to very wealthy households and lowering its rates would blunt much of the criticism against it while retaining many of its advantages. This article explains how the estate tax works and examines who is affected by it under current law. It discusses how reform would affect tax revenues, the distribution of tax burdens, farms and small businesses, and charitable giving and bequests. A concluding section discusses ways to reduce the complexity of the tax.

Notes from this section

1 Leonard E. Burman is a senior fellow at the Urban Institute, codirector of the Tax Policy Center, and a visiting professor at Georgetown University. William G. Gale is the Arjay and Frances Fearing Miller chair and deputy director of the Economic Studies Program at the Brookings Institution and codirector of the Tax Policy Center. Jeffrey Rohaly is a research associate at the Urban Institute and director of tax modeling at the Tax Policy Center. The authors gratefully acknowledge helpful comments from Jon Bakija, Gary Bass, Beth Kaufman, Rob McClelland, Janet McCubbin, Joel Slemrod, and Mike Udell. Fiona Blackshaw edited the document. Financial support from the Nathan Cummings Foundation is gratefully acknowledged.